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REIT Sector Crackdown Is Simply Foolish

Written by: Brad Thomas04/29/13 - 9:03 AM EDT

Tickers in this article:
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NEW YORK (TheStreet) -- More and more companies have been looking at the REIT structure as a way to unlock value in traditional shares. In what was previously more of a trickle of REIT conversions and spinoffs, the more recent activity has been viewed as more of a wave.

Signed into law by President Eisenhower in 1960, Congress intentionally formed a broad definition of real estate when it originally created REIT legislation. Later, in 1964, the IRS adopted the same broadness by recognizing that telecommunication towers and railroad-related assets would apply (the IRS applied railroads in 1969.)

Some of the most recent news has created a stir of sorts as certain fear that the fate of recent conversions and spinoffs could threaten the industry's tax-exempt status. Remember that in exchange for not paying federal income taxes, REITs, whose primary income streams are from real estate, are required by the IRS to distribute at least 90% of their taxable earnings to shareholders in the form of dividends.

But wait. It's clear that the increased demand is not driven by the corporate tax exemption -- because the IRS is going to get their money regardless -- either at the corporately taxed level or at the individual level (taxes paid by investors.) Instead, it seems that the strong demand is being driven by Mr. Market. REITs today are trading at very high multiples and that has created an environment fueled by low cost debt and equity.

Some fear that the increased demand -- including new subsectors like prisons, gaming, and billboards -- could spur an "IRS crackdown" and potentially cause the IRS to change or get rid of the rules that allow REITs to discontinue corporate-level tax as long as they distribute the bulk of their earnings as dividends. One vocal activist, Bill Ackman, founder of Pershing Square Capital Management recently suggested that REITs could spur changes harmful to the REIT industry.

In a recent conference at New York University's Schack Institute of Real Estate in Manhattan, Ackman said, "If you push the envelope too much, there will be a crackdown on the REIT industry." He went on to argue, "I am not a big fan of these really kind of specialty, non-real estate-type industries getting some kind of exemption to stick their assets in a REIT and then not pay corporate-level tax."